Financial Sustainability
Information Paper 17
Depreciation and Related
Issues
Revised February 2012
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Introduction
This Information Paper is one of a series of Information Papers about Financial Sustainability
and Financial Governance in Local Government.
The series of Information Papers was originally published in 2006 to 2011 as a part of the
Financial Sustainability Program. The history of that program and a complete list of
Information Papers and other resources including a glossary of terms and abbreviations is
provided on the LGA’s “Financial Sustainability” web page: http://www.lga.sa.gov.au/goto/fsp.
The entire series of Papers was revised in early 2012 to take account of legislative changes
and other developments. These Papers are addressed to, and written primarily for the
benefit of Council Members and staff, but they are also available as a resource for the
general public, and students of Local Government.
Depreciation – what is it?
Depreciation is an accounting concept that measures and spreads the cost associated with
the consumption of an asset over its useful life. The Australian Accounting Standards define
depreciation as ‘the systematic allocation of the depreciable amount of an asset over its
useful life’.1 For most Councils, depreciation is the third largest expense item appearing in
the annual financial statements. (‘Employee costs’ is usually the largest, followed by
‘materials, contracts and other expenses’.)
This Information Paper explains why accounting for depreciation is important, and discusses
how it can be measured. The Paper aims to provide an overview of these issues rather than
providing technical detail. More detailed and technical information is available, however.
See the ‘Resources’ section on the final page.
What do the Act and Australian Accounting Standards require?
Every Council, Council subsidiary and regional subsidiary must comply with Australian
Accounting Standards in preparing its annual financial statements.2 Accounting systems,
processes and data therefore need to be structured and maintained to achieve this
requirement.
The annual financial statements must include estimated values of the assets held at the end
of the financial year.
Accounting standards recognise two different types of assets:
 Current assets; and
 Non-current assets.3
1 Australian Accounting Standards Board AASB 116. “Property, Plant and Equipment” Definitions p12
http://www.aasb.gov.au/admin/file/content105/c9/AASB116_07-04_COMPjun09_07-09.pdf
2 Local Government (Financial Management) Regulations 2011 at Regulation 11.
3 AASB 101 provides at paragraph 66, that an entity must define an asset as a “current” asset when:
“(a) it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
(b) it holds the asset primarily for the purpose of trading;
(c) it expects to realise the asset within twelve months after the reporting period; or
(d) the asset is cash or a cash equivalent unless the asset is restricted from being exchanged or
used to settle a liability for at least twelve months after the reporting period.
An entity shall classify all other assets as non-current.”
2
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Current assets are liquid items (cash or items such as rates and other receivables that are
expected to be converted into cash) or items like inventories that will be used in operations.
Non-current assets typically are items held for use over several periods and include land,
buildings, plant and equipment and infrastructure such as roads, drains and footpaths.
The Local Government (Financial Management) Regulations 2011 (“the Regulations”)
require councils, council subsidiaries or regional subsidiaries to undertake revaluation of all
material non-current assets at a frequency that satisfies the requirements of Australian
Accounting Standard AASB 116.4 AASB 116 requires that revaluations be made with
sufficient regularity to ensure that the carrying amount of an asset does not differ materially
from that which would be determined using fair value at the end of the reporting period.5
Paragraph 6 of AASB 116 defines “fair value” as “the amount for which an asset could be
exchanged between knowledgeable, willing parties in an arm’s length transaction”.6 Fair
value is effectively the maximum amount the owner would be prepared to pay to acquire the
benefits of the asset if it did not currently own it.7
Determining classes of non-current assets that are material and therefore require regular
revaluation and those that are not, requires judgement and consideration of qualitative and
quantitative factors. As a rule of thumb, a class of non-current assets is unlikely to be
material if it represents less than 5% of the total value of non-current assets of an entity. It is
likely to be material if it represents more than 10% of the entity’s total value of non-current
assets.8 In practice this will typically mean that most Councils will need to revalue land and
land improvements, buildings and infrastructure but not plant, equipment, furniture and
fittings.
A revaluation must be carried out in accordance with Australian Accounting Standard
AASB 116 which requires a revaluation to be based on “fair value”. Revaluations of longlived assets such as roads are not necessarily required every year, unless there would be a
“material” difference, from one year to the next, in the value of the asset.9
AASB 116 also requires that the residual value and useful life assigned to an asset and the
depreciation method applied to depreciate it must be reviewed at least at the end of each
year.10
Why worry about depreciation?
Calculating depreciation is both more critical and challenging for Local Governments than for
most other Governments and businesses. Councils’ audited financial statements for 2009-10
indicated that depreciation represented 22% of their total operating expenses.
Local Government (Financial Management) Regulations 2011 at Regulation 12.
AASB 116 at paragraph 31.
6 AASB 116 at paragraph 6.
7 See Section 12.12 of Australian Infrastructure Financial Management Guidelines 2010.
8 See Section 12.6.3 of Australian Infrastructure Financial Management Guidelines 2010 for a
discussion on materiality.
9 AASB 116 at paragraph 31. For more information on how frequently assets should be revalued, see:
 page 8 below under the heading “Regularly Revaluing Assets” and
 the Model Financial Statements for the current year, at
http://www.lga.sa.gov.au/site/page.cfm?u=266 under the heading “Frequency of
Revaluation”
10 AASB 116 at paragraphs 31, 61.
4
5
3
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Councils have a wide range and large number of high value assets, relative to their revenue.
Many of these are long-lived infrastructure assets that are held for their entire usable life.
There is no market for trading second-hand infrastructure assets, so their fair value at any
time is hard to determine. Nor is it easy to determine exactly how long they will last in
service.
Even though it does not directly result in a cash outlay, depreciation is a real cost of
conducting business and given its magnitude, warrants close attention.
Depreciation is not easy to measure but with care and understanding a reliable estimate can
be made, in a cost-effective manner. An understanding of depreciation expenses is vital
when:





making decisions about the level and nature of services that the Council can
sustainably provide, based on an understanding of the full costs of providing all
services;
setting annual budgets;
developing long-term financial plans;
making pricing decisions even if full cost is not the basis for pricing; and
ensuring that all operating costs are included in rating decisions.
A Council which does not have a sound estimate of its depreciation expenses risks making
decisions blind to its long-term financial situation. It would not have reliable information on
which to base its rating and charging decisions. For example, significantly under-estimating
the cost of consumption (the using-up) of assets in providing services could lead to
inequitable rating between ratepayers at different points in time (intergenerational inequity). It
could also lead to an inability by the Council to be able to accommodate required asset
renewal in future and therefore maintain preferred service levels.
A Council may consciously and explicitly decide not to replace certain assets, or to operate
with fewer or lower standard assets, and thus provide fewer services, or lower standards of
services in future.11 However, if a Council wishes to at least maintain existing services and
service levels on an ongoing basis, it should generally strive to ensure that operating
revenue at least matches operating expenses (including depreciation costs).
Reliably calculating depreciation expenses necessitates keeping asset values up to date,
recognising and applying residual values to assets as appropriate and regularly reviewing
asset useful lives generally (and remaining useful lives of individual assets).
Accounting for assets
Accountants report costs differently depending on whether they are capital costs, or
operating costs.
Capital costs are costs of significant value that are expected to generate benefits over a
period longer than a year. They are shown as ‘assets’ in a balance sheet. Buildings, plant
and equipment are common classes of Local Government assets but usually infrastructure
assets such as roads are far more significant in total value.
Operating costs are typically day to day expenses. Generally, the benefits from the
expenditure are consumed in the short-term (e.g. fuel or electricity) to support either ongoing
activities or one-off initiatives that do not generate measurable long-lived benefits. Costs of
See a discussion of this issue in Financial Sustainability Information Paper No. 26: Service Range and
Levels at www.lga.sa.gov.au/got/fsp
11
4
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
maintaining an asset (e.g. servicing a vehicle or fixing a pothole, patrol grading of an
unsealed road) are also operating expenses because they do not extend the expected life of
an asset but are necessary to ensure that its assumed useful life and service potential are
able to be realised.
Depreciation is an example of an operating expense for a period that does not involve cash
spending. It is included along with all other operating expenses in the financial statements
and results in a reduction in the carrying value of assets in an entity’s balance sheet.
The amount of the depreciation expense shown in a Council’s financial statements will
depend on a number of factors including the:




value of the Council’s assets;
useful life of assets (which is influenced by the operating environment and the
Council’s required service standards from the assets);
Council’s asset maintenance programs; and,
method used to calculate the depreciation expense.
When should asset related costs be capitalised and when should they be expensed?
In order for a Council to be able to make responsible financial decisions based on
information contained in its financial statements, it is important that all underlying accounting
information be appropriately recorded. This requires a Council to have clear and sound
accounting policies and practices about when outlays will be capitalised and when they will
be expensed.12 Capitalising a cost means that it will be spread over a number of financial
reporting periods while expensing a cost results in it being recognised in the operating result
of a Council wholly in a single financial year.
A small value purchase like a $9.95 calculator might last a long time and provide ongoing
benefits but its modest cost would not warrant its capitalisation and subsequent depreciation
over future accounting periods. Instead it would be fully expensed in the financial year in
which it was acquired. Its impact on the income statement of fully expensing it in one year,
rather than over several, would be immaterial.
The cost of resealing a road should always be capitalised. The life of the whole road won’t be
extended by so doing, but AASB 116 requires individual component parts of assets to be
recorded separately where their cost is relatively significant (see also discussion below on
depreciating assets by their component parts). As such the seal of a road is treated as an
individual asset and it therefore follows that the cost of its eventual replacement (i.e.
resealing the road) should be capitalised.
A decision on whether a cost should be treated as a capital cost or expensed is not always
clear cut. Where road repairs involve resealing or re-sheeting a relatively large area (e.g.
because it is cost effective to do so) should this be treated as an expense? In practice, a
long road is broken down in an asset register not only into component parts but also into
section lengths (e.g. between intersections). If, when carrying out repairs, the whole of a
road between two intersections is resealed or re-sheeted, and to a standard that would make
it unnecessary to do so again when adjoining sections are resealed or re-sheeted, the outlay
may be appropriately capitalised.
See Financial Sustainability Information Paper No. 18: Financial Policies and Procedures at
www.lga.sa.gov.au/got/fsp
12
5
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Adopting a policy on the threshold for the recognition of expenses as capital or maintenance
(this will vary for different assets) will make these sorts of decisions easier and consistent.13
How is depreciation measured?
Careful consideration is required on the best approach to calculating the appropriate annual
depreciation expense so as not to understate or overstate operating expenses on which
revenue decisions are made and financial performance is assessed. There is no single
correct answer applicable in all circumstances.
Australian Accounting Standards require that depreciation methods reflect “the pattern in
which the asset’s future economic benefits are expected to be consumed.”14
The economic benefits available from an asset can be thought of as its service potential.
Depreciation simply attempts to objectively account for the using-up of an asset’s service
potential.
Long-lived assets often deteriorate negligibly early in their lives and the rate of condition
deterioration gradually increases over time. An asset’s value is based on its remaining
service potential which may or may not be materially related to condition, depending upon
the services it is intended to provide. Remaining service potential may be consumed equally
over time, even if the rate of asset deterioration increases over time. In many instances
services generated from an asset are similar, if not identical, when an asset is older and in
poorer condition, than when it was newer and in better condition.
Even when service levels are closely correlated with condition it does not follow that an
asset’s value correlates with condition, nor that its loss of value (depreciation) correlates with
decline in condition between periods. Where condition is a key factor in determining the
value of an asset it is not current condition but expected condition over the remaining useful
life that determines its value. An asset may be in good condition now, but if its condition is
expected to rapidly deteriorate in the near future it will have a lower value than an asset in
similar condition which is expected to have a slower rate of future condition degradation.
An asset should be held for the amount of usage or length of time for which it can provide
service at the required level in the most cost effective manner. An asset’s remaining useful
life is therefore the amount of time until it is expected to be replaced or renewed. The value
of the asset at the end of its useful life (less any material associated disposal costs) is its
residual value.
It is not always easy to reliably predict how long an asset will provide a cost-effective service,
what its value will be on disposal or at the end of its useful life (“residual value”) and the
pattern in which its service potential is expected to be consumed. It is therefore also not
easy to determine how much of the asset’s value to expense via a depreciation charge each
financial year.
So how should the consumption of assets be measured and apportioned over time?
See Financial Sustainability Information Paper No. 18: Financial Policies and Procedures at
www.lga.sa.gov.au/got/fsp
14
AASB 116; paragraph 60.
13
6
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Asset Consumption and Asset Lives
Depreciation methods are all based either upon the period that an asset is expected to be
available for use, or its pattern of usage or production during this period. A Council should
choose a method that best practically reflects the way an asset’s service potential is used up.
If an asset’s consumption is influenced more by usage than by its age, and it is easy to
measure usage, then it makes sense to base depreciation rates on the measured usage.
Plant, like graders for example, may be depreciated on the basis of hours of operation and
vehicles perhaps on kilometres travelled.
Many Local Government assets provide relatively similar levels of service continuously over
their useful lives (e.g. possibly a computer, building, footpath, road or stormwater drain) and
are more appropriately depreciated on the basis of the period of expected ownership (i.e. the
asset’s useful life to the owner) rather than usage.
Within a Council, or between Councils, similar assets may have different useful lives and
therefore be depreciated at different rates. Even with regular patrol grading, the pavement
on an unsealed road will gradually wear away. Councils need to determine the ride quality
they wish, and can afford, to strive to maintain15 and this together with material quality and
availability, safety, and operational and environmental factors will determine how often such
roads are to be re-sheeted. As a result, a Council might have some unsealed roads that it
believes warrant re-sheeting frequently, say every 8 years, and others that it considers
should be re-sheeted only say, every 15 years. The period over which the pavement is
depreciated should be consistent with these varying expected useful lives. Where a road is
formed but not sheeted, or was originally sheeted but the pavement has effectively worn
away and is no longer re-sheeted (either for reasons of financial constraint or changes in
needs) then there is no pavement to depreciate.
In each case above the depreciation expense reported in the income statement should
reflect the service potential that was consumed in the financial year. A Council that
effectively provides a lower standard of service, or has favourable environmental and
operating conditions that enable assets to last longer, can expect lower annual depreciation
expenses.
Remaining useful lives need to be reviewed at least at the end of each annual reporting
period and adjusted whenever there is reason to do so. In the early and middle years of the
expected useful life of a long-lived asset there may be little evidence to warrant an
adjustment to an asset’s life. By the time the asset has reached two-thirds or three-quarters
of its initial assumed useful life it is likely that judgements reviewing remaining useful life can
be made with greater confidence. It is likely that adjustments to remaining useful life will
need to be made with more frequency as the asset approaches the end of its remaining
useful life.
Councils sometimes find that assets they have in service have been fully depreciated. In
practice, if an asset is still providing service it must have value. In these circumstances it is
likely that its rate of depreciation was over-stated and its remaining useful life or carrying
value hasn’t been appropriately revised upwards when warranted. This should be addressed
when the relevant class of assets is next re-valued.
See Financial Sustainability Information Paper No. 26: Service Range and Levels at
www.lga.sa.gov.au/got/fsp
15
7
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Approaches to calculating depreciation
AASB 116 refers approvingly to the straight-line method, the diminishing balance method
and the units of production methods of calculating depreciation but does not exclude other
methods.16 AASB Interpretation 1030 prohibits condition-based depreciation.17
Any one of the three supported methods referred to in AASB 116 may be more appropriate
for use in Local Government, in different circumstances. They are briefly described below.18
Straight-line method
The straight-line method allocates an equal amount of depreciation each year
(ignoring the impact of any review of asset values, useful lives and residual values)
based on the difference between the initial purchase price and the expected value at
the time of anticipated disposal, spread over the full period of ownership.
Diminishing balance method
Assets that have a well established second-hand market like motor vehicles often
lose proportionately more resale value early in their lives. In these circumstances the
diminishing balance method, which calculates depreciation by applying a fixed
percentage rate to the value of the asset net of the accumulated depreciation to date,
may be most appropriate. This method results in a proportionately lower depreciation
charge each subsequent year over the useful life of an asset (ignoring the impact of
any review of asset values, useful lives and residual values).
Units of production method
This method results in a charge based on the use or output of the asset each period.
It may be an appropriate choice when service potential consumption is related more
to usage of the asset than time. For example, the rate of consumption of the service
potential of a piece of plant or equipment such as a backhoe or grader may correlate
best with hours of use, or a truck based on kilometres travelled. In these cases the
depreciation charge would be expressed on a per operating hour and per kilometre
travelled rate respectively, and the annual charge would vary with actual usage.
Depreciating assets by their component parts
Paragraph 43 of AASB 116 requires each part of an item of property, plant and equipment
with a cost that is significant in relation to the item’s total cost, to be depreciated separately.
The benefits of doing this are particularly apparent when the component parts have
significantly different useful lives.
A sealed road for example can be thought of as made up of three key components:



its base (earthworks);
the pavement itself and
an asphalt seal.
The base can normally be expected to last a very long time (in many cases indefinitely) with
the pavement having a shorter expected life (e.g. 40 years) and the seal a much shorter life
(e.g. 20 years). Each of these three components needs to be recognised separately. In this
typical example, the pavement and seal should be depreciated at different rates and the
base should not be depreciated at all (if it is assumed that the base has an indefinite life). If
AASB 116 at paragraph 61.
AASB 1030 at paragraph 8.
18 For a more extensive discussion of depreciation methods, see IPWEA Australian Infrastructure
Financial Management Guidelines, section 12.13.3, page 12.65.
16
17
8
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
the pavement and seal were depreciated as one asset then this could lead to a significant
over or under-statement of costs for a period depending on which life expectancy was used.
For example, if it was assumed that the pavement and seal would last 40 years then the
depreciation expense calculated and recognised in the accounts would be lower than the
rate of deterioration of the seal component, leading to an understating of the cost of
consumption of the combined asset. It would then be more likely that current users of the
road would be undercharged for their usage. Conversely, depreciating the pavement and
seal together over 20 years would mean that the rate of consumption of the road had been
overstated, with the likelihood that users would have been charged more than the cost of the
services that had been used up.
Unsealed roads should be depreciated taking a similar approach, having regard to the
separate components of the base, and the sheeting.
Measuring Asset Values
The depreciation rate and method selected should reflect the rate of consumption of an
asset’s service potential. In order to determine the cost of this consumption, the depreciation
rate needs to be applied to the value of the asset. Valuing assets for recognition in financial
statements is not as simple as it may first appear.
Australian Accounting Standard AASB 116 requires assets to be recorded either at fair value
or at historical cost less accumulated depreciation. However, as noted above, the Local
Government (Financial Management) Regulations 2011 require regular revaluations of the
carrying value all material non-current assets to their updated ‘fair value’.
Paragraph 33 of AASB 116 advises that in the absence of market based evidence, fair value
may be estimated using a depreciated replacement cost basis i.e. the cost of replacing the
asset today less the value of the asset that has been ‘used up’ to date. Given that there is no
market for the sale and acquisition of many local government infrastructure assets they
should be re-valued based on their estimated depreciated replacement cost. There is,
however, usually a market for land and buildings. Where relevant evidence exists such
assets should be valued based on market prices.
Where the specialised nature of the item of property, plant and equipment means that
market-based evidence of fair value is not available it does not automatically follow that an
asset should be valued based on a depreciated replacement cost approach. The Australian
Infrastructure Financial Management Guidelines advise that; ‘Where the future economic
benefits embodied in the asset would not rationally be replaced if the entity was deprived of
the asset, the asset should be measured at the net present value of future cash flows from its
highest and best use if this information is able to be derived. Where there is no regular cash
flow generated from the asset, the net present value of future cash flows is the disposal
value’.19
Councils often receive assets free of charge or at less than market value e.g. infrastructure
provided by developers. These assets need to be recorded upon acquisition not at their cost
of acquisition, but at fair value.20 This allows stakeholders to appreciate the full value of
assets a Council is responsible for managing and the cost of using up their service potential
as reflected in the recorded annual depreciation charge.
19
20
AIFMG 2010, p.12.58.
See AASB 116 paragraph Aus 15.1.
9
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
Regularly revaluing assets
Assets can have a change in value for reasons other than as a result of their consumption
with use or age. As a result of inflation it often costs more to replace an asset than its
original purchase price. Advances in technology, exchange rate movements and changes in
market supply and demand conditions can also mean that prices for some assets may
increase by considerably more or less than the inflation rate (and may even decrease in
price) between periods.
Paragraph 31 of AASB 116 requires revaluations to be made with sufficient regularity so as
to ensure that the carrying amount of assets at the reporting date is not materially different
from that which would be determined using the ‘fair value’ definition. In practice external
auditors are usually satisfied if a Council formally reviews all asset values about every 3 to 5
years but also may require some classes to be reviewed more frequently where there is
reason to believe that fair value has changed significantly. By keeping asset values up to
date a Council provides readers of its financial statements with more accurate information on
the current value of assets that it has under management and the cost, in today’s prices, of
the consumption of its assets’ service potential during the period.
Where a Council re-values all its assets in one period and then not again for a period of 3 or
more years it may then discover that the large increase in the value of its assets following
revaluation has caused a corresponding jump in its recorded depreciation expenses and a
marked downturn in its financial operating result. The reality is that the reported operating
result for such a Council in the intervening years between revaluations would probably have
been ‘flattering’ because its depreciation expense would have been based on asset values
that were progressively becoming out of date.
Re-valuing (say) one-third of all assets (by value) each year rather than all assets every (say)
three years would generally result in more up to date information over the three years and
smooth the impact, arising from changing asset values, on the depreciation expense
recorded in the operating statement. Where a Council re-values only a proportion of its
assets in a year it must re-value an entire class of assets (e.g. all sealed roads) and not just
particular assets within a class.21
The more regularly assets are re-valued the more reliable will be a Council’s reported
depreciation. There is obviously an additional cost in more regularly revaluing assets and
the costs of so doing need to be considered relative to the benefits. It should not be
assumed that Councils need to engage professional valuers or external consultants to
determine ‘fair value’ revaluations of all their physical assets. Valuers are well positioned to
assist where markets exist for the sale of assets (e.g. land and buildings) but market-based
evidence is usually lacking in regard to the valuation of most infrastructure assets. Councils
are often likely to have the knowledge and evidence in-house from their infrastructure
construction and asset management work to accurately assess the replacement value of an
asset and the proportion of economic life remaining in existing assets. Providing that this
evidence is well documented, it is likely to be acceptable to an external auditor as a basis for
in-house revaluation of infrastructure assets. Councils adopting this approach should
consider obtaining, from time to time, independent expert advice on the appropriateness of
the valuation methodology being used.
Councils should also consider annually adjusting asset classes with significant value (e.g.
infrastructure) by a suitable index, between comprehensive periodic revaluations. Australian
Accounting Standards are silent on the issue of indexing asset values between revaluations.
21
AASB 116 at paragraph 36.
10
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
An external auditor will wish to be satisfied that an applied indexing factor is appropriate to
the Council’s circumstances.
The Australian Bureau of Statistics (ABS) produces a range of price indices which might be
appropriate and Transport SA has developed an index which it applies to its road network
annually (and which is approved for such use by its auditor, the Auditor-General). Where a
Council has built a road during the year and as a result is aware of up-to-date costs, this
information also may be useful in determining current standard unit rates that can be applied
to revalue its other similar assets. Regardless of which index is used it needs to be
recognised that it is by definition no more than an approximation and is not a substitute for a
formal regular periodic revaluation of asset values.
Impairment of assets
An asset is considered to be impaired when the value at which it is carried in a Council’s
financial statements is greater than its depreciated replacement cost.22 While depreciation
estimates the planned consumption of an asset, impairment measures unexpected losses in
its value (e.g. damage to a road caused by a flood). An impairment loss is recorded as an
expense at the time the impairment is identified. 23
AASB 136 requires reporting entities to have in place a system to identify indicators of
impairment and to test for impairment whenever those indicators have been triggered. 24 At
each reporting date an assessment must be made as to whether there is any indication that
any assets are impaired.25
‘Greenfields’ and ‘brownfields’ considerations in valuing assets
Engineers often refer to the initial construction of an asset on otherwise undeveloped land as
a ‘greenfield’ situation and the replacement of it, on a now developed site, as a ‘brownfield’
situation. The term ‘brownfield’ can also apply when a new asset is constructed on a site
that has previously been developed for other purposes and there are either additional costs
or savings with construction of a new asset at this site compared with at a ‘greenfield’
location.
There is sometimes conjecture amongst engineers, asset managers, accountants and others
in Local Government and elsewhere as to whether assets should be valued (and therefore
the annual depreciation expense determined) based on a ‘greenfields’ or ‘brownfields’
scenario.
Australian Accounting Standards make no reference to the terms ‘greenfields’ and
‘brownfields’. Ensuring assets are recorded by their significant component parts makes it
easier to determine fair value taking account of ‘greenfields’ and ‘brownfields’ implications.
In many instances revaluation of asset components will effectively assume a ‘brownfields’
scenario.
So which depreciation method should Councils use?
A Council’s pricing and rating decisions should be based on recovering operating expenses.
However some depreciation methods result in higher or lower depreciation expenses in any
particular year depending on whether an asset is old or new. The community may find it
AASB 136 Impairment of Assets, at paragraphs 8.
See Australian Infrastructure Financial Management Guidelines Section 10 for more information on
accounting for impairment.
24 AASB 136 at paragraph 12 (e).
25 AASB 136 at paragraph 9.
22
23
11
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
hard to embrace pricing and rating decisions that are impacted by the age of the Council’s
assets. For example the use of the diminishing-value method would lead to recording a
higher cost for the operation of a community bus when the bus is new than when it is old (all
other things being equal).
Australian Accounting Standard AASB 116; Property, Plant and Equipment requires the
method chosen to reflect ‘the expected pattern of consumption of the future economic
benefits embodied in an asset’26 However, straight line depreciation is commonly applied
in Local Government and elsewhere and is widely accepted by external auditors as
appropriate and conforming with Australian Accounting Standards. This method is easy to
calculate and understand and it makes sense therefore to use the straight-line method
coupled with frequent re-valuation of assets unless an alternative is considered more
appropriate.
Consideration also needs to be had to the costs and benefits in gathering information on the
pattern of consumption of the future economic benefits from use of the asset. The AASB
Framework for the Preparation and Presentation of Financial Reports states ‘the benefits
derived from information should exceed the cost of providing it’.27
Most Councils have a wide range of different types of assets with a relatively even spread of
remaining useful lives. In these circumstances it is unlikely there would be a material
difference in aggregate annual depreciation expenses regardless of the method of
depreciation applied providing that assets:




are regularly and appropriately revalued;
are appropriately componentised for depreciation purposes;
have been assigned appropriate useful lives that are regularly reviewed to take
account of actual asset performance; and
have been assigned appropriate residual values.
Can we compare depreciation between Councils?
It is sometimes suggested that where two Councils have a similar stock of assets their
annual calculated depreciation expense should also be similar. However, there are several
reasons why even when Councils have identical assets they may appropriately record
significantly different depreciation expenses in any given year.
First, two Councils may have similar stock of assets but their communities may have different
service level requirements or expectations from some, or all, of these assets. The impact of
this may be that one Council adopts a longer life and therefore records a lower depreciation
expense for these assets than the other Council.
Second, an asset may have cost one Council (and/or be appropriately valued by it at) much
more or much less than the other. For example constructing or re-sheeting a road in a
locality where materials must be trucked long distances is likely to add significantly to road
work costs. There are also significant legitimate differences between Councils as to the
magnitude of costs they treat as overheads and how they are then allocated. Some Councils
have higher overhead costs or allocate a higher proportion of their indirect costs as
overheads to the cost of works and services compared with others (for example their ratio of
direct capital to direct operating costs upon which overheads are apportioned may be
higher). Therefore, even when the depreciation rate is the same between Councils the ‘cost’
26
27
AASB 116 at paragraph 61.
Framework for the Preparation and Presentation of Financial Reports, AASB, 2007, Para 44, p20.
12
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp
LGA ‘Financial Sustainability’ Information Paper No. 17: Depreciation and Related Issues
– Revised February 2012
or ‘value’ to which the rate is applied can vary, resulting in a difference in the depreciation
expense recorded.
Furthermore an identical asset may last longer or wear out more quickly if it is used in
different circumstances. A road heavily trafficked by large vehicles is likely to reach the end
of its economic life (i.e. the point where it is more cost-effective to replace than repair) much
sooner than a lightly used one that is very rarely used by heavy vehicles. Where such
circumstances can be reliably predicted depreciation rates should reflect actual usage in
practice. Similarly, soil or climatic conditions and/or the quality of available materials can
have a big impact on the expected life of a road. If the impact of these factors is material and
can be reliably predicted then depreciation rates should take this into account.
Even if two Councils were identical in all respects they would still record different levels of
depreciation expenses if they both re-valued their assets in aggregate and at the same
frequency but in different years (unless they both re-valued annually).
In their work, external auditors review the carrying value of assets and the depreciation
method and rates applied, to satisfy themselves that all conform to Australian Accounting
Standards. Typically, an auditor will seek to establish that the values and useful lives
assigned to assets and methods and rates of depreciation are consistently applied and
appropriate, based on local environmental and operating circumstances, and are relative to
accepted practices elsewhere.
Resources
The Institute of Public Works Engineering Australia (IPWEA) publishes the Australian
Infrastructure Financial Management Guidelines (AIFMG, updated 2010). In addition, the
LGA publishes annually the Model Financial Statements. These resources are available on
the LGA’s web site at http://www/lga.sa.gov.au/goto/finance.
Acknowledgements
The contributions of John Comrie of JAC Comrie Pty Ltd and David Hope of Skilmar Systems
Pty Ltd in the preparation of this paper are acknowledged. The development of this
information paper has been assisted by funding from the Local Government Research and
Development Scheme.
13
DME: 78740
LGA Financial Sustainability Program – www.lga.sa.gov.au/goto/fsp